2010-06-30 16:48

China's order to halt domestic coal price increases signals the government may hold off on raising electricity rates until later this year when inflation expectations become clearer, JPMorgan Chase & Co said today.

Further intervention in prices isn't expected because inflation may moderate starting in July or August, Jing Ulrich, chairwoman for China equities and commodities, said in an e- mailed note.

Consumer prices in China rose at the quickest pace in 19 months in May, prompting the government to find ways to fight inflation.

The government ordered coal companies to refrain from initiating spot price increases and forbade them from amending prices agreed on in their annual supply contracts with power producers, according to a statement on June 25. [Coal firms asked to keep coal prices from rising]

"This effort to contain coal prices provides a near-term alternative to hiking electricity prices at a time when policy makers do not want to see inflationary pressures increase," Ulrich said. "The government may take further action on electricity pricing later this year, when there is more clarity on the full-year CPI growth."

More than 40 percent of power producers operated at a loss between January and May, she said. The benchmark contract price signed between power producers and China Shenhua Energy Co, China's biggest coal supplier, for 5,500 kilocalories coal is about 570 yuan ($84) per metric ton, according to the note. Spot prices are at about 755 yuan per ton.

Future margins

The move has affected sentiment on future margins of Chinese coal companies, even though they "continue to make good profits at current price levels," Ulrich said.

Chinese coal stocks have fallen since the government announcement June 25. Shares in China Shenhua have dropped 8.9 percent in Hong Kong trading by 10:29 am local time compared with the close on June 25. China Coal Energy Co slipped 13.5 percent in the period.

Under a current pricing system, the government should increase power tariffs to absorb 70 percent of the gains in costs to electricity generators when the average spot coal price rises by more than 5 percent over a six-month period, she said.

China's balance of coal supply and demand should improve in the second half of the year as electricity consumption growth slows and a major inland railway used for transporting coal restores operations after maintenance, Ulrich said in the note.

Coal reliance

Lesser reliance on coal-fired power plants during the summer rainy season also lowered demand for the fuel, Ulrich said. Hydropower accounted for 16.4 percent of total electricity production in May compared with 12.5 percent in April, she said.

On the supply side, maintenance of the Daqin railway was completed in May, leading to higher coal inventories at power plants before the peak summer demand season, she said. Stockpiles at major power plants rose to 18 days of use as of June 20 compared with 15 days at end-March, according to Ulrich.

The Daqin railway connects the northern province of Shanxi, one of two China's biggest coal-producing region, to Qinhuangdao, the nation's largest port for the fuel.